HOW STEVE KNOWS THE GUEST

Steve met Tom at Mario Gabelli’s conference in Omaha and pitched the podcast to him. As Tom was coming to London anyway, Steve decided to wait for his trip and record in person which is always preferable. By coincidence, Steve happened to be in Edinburgh later that week, when Tom presented at the Library of Mistakes and at a Markel mini-reunion. In spite of listening to Tom three times in four days, Steve didn’t hear more than one or two of the same stories twice.

Contents

00:03 – Investment success stories
13:52 – Hedge fund insights
34:14 – AI’s impact on industries
52:23 – Berkshire’s market recognition
01:00:00 – Earnings management concerns
01:12:50 – Wisdom in investment strategy

Transcript

STEPHEN CLAPHAM: Hi, I’m Steve Clapham and welcome to the Behind the Balance Sheet podcast, where we meet leading investors and commentators and educate ourselves about the world of investing and the world. Our mission is to remove some of the mystique around investing and improve our understanding of successful investors’ strategies and tactics.

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STEPHEN CLAPHAM: Tom Gayner, CEO of Markel Group, is one of the most underrated Capital allocators of the current era. He has a long-term, extremely thoughtful approach to investing and is an incredibly modest individual. When I asked him about selling CarMax, his then second largest position, instead of telling me that the stock had subsequently halved, he explained that he had made a mistake. His thesis was wrong.

STEPHEN CLAPHAM: I don’t know why Gayner isn’t more widely recognized as an investment genius. Markel’s stock Floated at $8 is now $1,950, and the biggest chunk of those gains has been achieved under his stewardship. His patient, long-term, steady approach to investing is a model for any private investor, and the envy of many professionals who aren’t afforded the time to think in decades, as Tom does.

STEPHEN CLAPHAM: When I asked about the underperformance of Berkshire Hathaway, his largest position, down over 30%, relative to the S&P this year, Tom remarked, there’s only been six months since the AGM when Buffett announced his retirement. Buffett has been doing this for 50 years. We covered a lot of ground in this conversation, but I still had a long list of questions at the end.

STEPHEN CLAPHAM: Tom describes himself as a plodder, but he has acute observation, is an incredibly thoughtful investor, is full of wisdom, and is a very likable individual. He’s just… A thoroughly decent human being. I was so pleased to meet him in person on his recent visit to London.

AD: And I’m sure you will enjoy our conversation.

STEPHEN CLAPHAM: So Tom, welcome to the podcast. I’ve been really looking forward to this. It’s been some time coming because we wanted to do this in person, and luckily you’re in London on route to Edinburgh later in the week. And I always start the same question. I always start by asking, did you always want to be an investor?

TOM GAYNER: Well, I always wanted to have resources and have some means. So I did not know investing and being an investor was the technical definition of perhaps how to get there. But I grew up with my father as my chief role model. And he was a CPA, a chartered accountant by training and an entrepreneur who had a small business and did real estate things. And so I just grew up around it and always enjoyed the commercial world.

STEPHEN CLAPHAM: And you started as a stockbroker or you started as an accountant?

TOM GAYNER: Started actually as an accountant. And again, The background and history of that was that my father was a CPA, and I admired him greatly, and his office was in our home. So part of the— old farmhouse in which we lived only had air conditioning in two rooms, one of which was my parents’ bedroom, the other which was my father’s office. So I spent a lot of time in my father’s office.

TOM GAYNER: So I would just be there and I would hear him talk to people on the telephone. People would come in and out to talk with him or work on specific things. So really from my earliest memory, I cannot remember not being at his knee and being around him. So By osmosis, I picked up so much in the way of business and how one gets along with people and how you transact.

TOM GAYNER: And because he was an accountant, I thought that was what accountants did. So that was my definition of accounting. Now, upon graduating from university, I went to work for, at that time, it was Coopers and Librand, the predecessor firm of PricewaterhouseCoopers. And they were known as the big eight firms at the time. Now they’re, I guess, known as the final four.

TOM GAYNER: But the counting of inventories and doing journal entries and things of that nature was something extraordinarily different than what I witnessed my father doing. So I realized that while that professional degree is quite helpful, and in fact, the discipline of accounting is extraordinarily helpful to an investor, your own work would be part and parcel of how you try to connect the world of accounting and finance together.

TOM GAYNER: It’s extraordinarily helpful. But I came to work as a stockbroker slash analyst. For a small investment firm. And that is indeed how I got started professionally as an investor.

STEPHEN CLAPHAM: And then you picked a great investment for Steve Marcao. Was it zero coupon bonds, KKR? Well, yes, that story.

TOM GAYNER: So I was working at a firm called Davenport & Company of Virginia, which is an employee-owned firm, still going today. I was very happy there. I worked there from 84 through 90. And I guess it was Valentine’s Day, 1980, 1990.

TOM GAYNER: When the junk bond market crashed, Drexel Burnham went bankrupt that day. And my partner and friend who I worked with quite a bit, we knew nothing about bonds other than what we would know as accountants. We were equity guys. And we said if there was ever a day where we were going to buy a junk bond, this would be the best day to do it.

TOM GAYNER: So we sat there and penciled out some things and thought about some things. And we thought about what would be a good choice. And we came to the conclusion that the most credit worthy of that particular class was RJR Nabisco, which had been the subject of an LBO, as they were known at the time, leveraged buyouts.

TOM GAYNER: And they had a security trading that was a zero coupon paying kind bond. And it was trading for about 30 cents on the dollar. And it had the proviso that it needed to be refinanced and trade at par in 94. So, um…

TOM GAYNER: This seemed very attractive, and through some back-of-the-envelope calculations, we thought it might be worth 70 cents on the dollar or something like that in a reorganization. Well, it was unusual security in that there had been a change in the tax law previously called TEFRA, which meant that if you owned a deep discounted bond, you had to accrete the phantom interest income to your reported income.

TOM GAYNER: You had a tax liability just from the accretion, although you didn’t have any cash to pay that tax bill with. So generally speaking, most people were not interested in buying that particular security just because you had to come out of pocket for the taxes and you really didn’t know the credit quality.

TOM GAYNER: Also, for things like IRAs or retirement plans, one would think it’s perhaps a bit of a gamey security and not quite of the fiduciary nature or quality that something like that should be. So it was really cool. Quite orphaned and stranded.

TOM GAYNER: Now, I happened to know because of my familiarity with Markel and the Markel family and the transactions that had taken place for Steve to be in the position that he was in, that they had borrowed a fair amount of money in order to buy shares from their parents, the second generation. So they had interest expense. And with that same tax law, interest expense was only deductible to the extent you had interest income.

TOM GAYNER: So I put two and two together and I called Steve and I said, you’re the one person in the world who this might make sense for. Because while you have this accretion of phantom interest income, it will not create an out-of-pocket tax liability for you. And I think it’s a very good investment. And that was in February. And, I think by, by the 1st of December, those bonds had been refinanced at par.

STEPHEN CLAPHAM: From 30 cents.

TOM GAYNER: From 30 cents. Yeah. And I think about a week later I was working at Markel.

STEPHEN CLAPHAM: Wow. It was a great story. And you’ve been there.

STEPHEN CLAPHAM: 30 plus.

TOM GAYNER: 35 years now. Yes.

STEPHEN CLAPHAM: Yeah. That’s an amazing story.

STEPHEN CLAPHAM: I was just wondering, I mean, I’ve got two sort of big questions, which, I mean, they might be impossible to answer, but I know people will be interested and I’d love to get your perspective on them. If Berkshire had been the only model of using the insurance flow to build a business, you’d understand why there wouldn’t be many emulators.

STEPHEN CLAPHAM: But there’s Markel and there’s a couple of others. Now, all the private equity players are starting to do a similar thing. But Why do you think this hasn’t become a more standard model?

TOM GAYNER: I think that’s a fascinating question and really worth some deep thought because you are correct. It has not become a widely spread model. And I can recall a number of years ago, this goes back 20 years or so, there was a Wall Street analyst who visited Markel and they were doing their due diligence and work.

TOM GAYNER: And at the end of the day, the gentleman looked at me and somewhat scoffed. And he said, you know, the problem with you guys is you’re trying to be just like Berkshire Hathaway.

TOM GAYNER: To which I replied, who would your otherist be like? That seemed like a pretty good role model to me. But it is amazing to me that there appears to be an emotional reaction against what Berkshire has done.

TOM GAYNER: And I’m trying to understand that. To some extent, Buffett has taken on, along with his partner Charlie Munger, who is extraordinarily helpful to him. You take on personal responsibility to behave differently than what the crowd would have you do or what the, as Buffett and Munger were talking about, the institutional imperative.

TOM GAYNER: You are behaving differently. And that’s like that zebra is too far away from the center of the herd. So there’s a lot of evolutionary practices and wiring and sensations in people that cause us not to want to be too far from the center of the herd.

TOM GAYNER: And to have the just psychological stamina and courage and sense of independence that it takes to be someone who’s willing, able. I won’t go so far as to use the word comfortable because there are times when it feels deeply uncomfortable and now might be a bit of some of that time.

TOM GAYNER: So you see that. I think that is one of the forces that keep people from doing it. Number two, when you think about things in terms of principal-agent relationships. Buffett has… Acted as a principal his whole life. And in fact, when he was working for Ben Graham and Ben Graham offered him the ability to stay and build the firm, Buffett turned that down because he really wanted to work for himself.

TOM GAYNER: And as he says, you know, invest in himself. So he has operated both financially and more important psychologically as a principal his whole life.

TOM GAYNER: So he’s sort of acted as if it was his own money. When you’re an agent and you’re a manager, you’re a hired professional, you’re a client kind of relationships, and you’re at their whim to continue to have your job, you need to be able to explain and communicate and convince and have psychological buy-in from someone else. Now, think about your closest relationship that you have in your entire life. Maybe it’s your spouse.

TOM GAYNER: I’ll speak personally. I am happily, happily, happily married for over 40 years.

TOM GAYNER: But I will tell you, there are times even when my spouse and I disagree about things and don’t see it that way. So the ability to operate as a principal and not have to explain and get someone else to buy into what you’re doing is a very important component of how one can pull off the Berkshire model, which we’ve been fortunate enough to be able to do. And then the third point, and you bring up the interesting.

TOM GAYNER: Notion of the current examples of where other people are starting to invoke the Berkshire model. Well, that was true when Buffett was launching and in the early days of Berkshire as well. So if you think about Gulf and Western and ITT and some of those conglomerates of the 60s and 70s and lingering from the nifty 50 kind of era. A number of them had insurance subsidiaries. The model actually existed.

TOM GAYNER: It was not the model that was new. It’s not the model that was great. It’s not the model that was flawed. It was the skill of the person doing the modeling and piloting the craft, so to speak. Buffett has been singular in his ability to do so.

TOM GAYNER: But other people tried then. They tried with different objectives, less pure motives perhaps. And it worked for Buffett. It didn’t work so well for the others. And perhaps we might be in a similar era today.

STEPHEN CLAPHAM: And this acting as principal, I mean, you were able to do this because you had the trust of the Markell family.

TOM GAYNER: I think it’s a combination of things. So obviously, yes, the trust and conviction and courage and support of the Markell family was extraordinarily important.

TOM GAYNER: I do want to salute and appropriately acknowledge the role of my wife, Susan, who has been a fabulous partner in every way possible that can be imagined, not the least of which is economic. So when I started at Markell, my wife was gainfully employed as a chemical engineer for the DuPont company. So I figured.

TOM GAYNER: Either this will work and we have a realistic shot at building something along the Berkshire Hathaway lines, or if it fails, at least Susan will keep me from starving. So that is no small thing to have that psychological and financial safety net in order to more effectively act as a principal and not be fearful about where your next meal is coming from.

STEPHEN CLAPHAM: Thank you for that. The other question I just wanted to touch on briefly is Berkshire has underperformed 30. Plus percent this year, which is, I mean, meaningful underperformance.

STEPHEN CLAPHAM: I just wondered what was your take on that? And do you think it’s down to Mr. Buffett’s upcoming retirement? I mean, it seems implausible to me, but that’s what the press are talking about.

TOM GAYNER: One thing you’re talking about is the timeframes involved. So I think that statistic you just cited is from the annual meeting where the announcement was made. Relative to today, so that would have been first weekend in May till here we’re chatting early November. So if I’m doing math in my head correct, you’re talking about six months.

TOM GAYNER: He’s had over a 50-year run running Berkshire. So the idea of what happens in any particular six-month period is irrelevant, number one. And when you consider the way he does things and the singularity and the North Star that he uses, it doesn’t really include short-term comparisons to the S&P 500.

TOM GAYNER: So I don’t think it enters his mind that much. No, I’m sure it does. Exactly. And similarly, to the best of my ability, I try not to let it enter my mind as well. And I think it might be speaking to what’s going on in the rest of the marketplace. Yeah, yeah. As much if not more so than what’s intrinsically happening in Berkshire.

STEPHEN CLAPHAM: It’s interesting because I would spend quite a bit of time if I owned, so Berkshire’s your biggest position.

TOM GAYNER: Correct.

STEPHEN CLAPHAM: So you’re intimately familiar with what’s happening. If my biggest position underperformed by 30%, I mean, I would be in serious trouble at a hedge fund, right? Obviously.

STEPHEN CLAPHAM: But the reason for it would be something that would worry me. It would keep me awake at night because I was thinking, oh, crikey, have I missed something? Now, obviously, you’re intimately familiar with Berkshire, so it’s almost impossible there’d be something you would miss. Is that what keeps you…

TOM GAYNER: No, I’m going to fully allow for possibilities that I missed something. But I think you bring up an interesting structural point. So your statement that you just made was if I was running a hedge fund, I would be very nervous about seeing this happen.

TOM GAYNER: Well, think about sort of what comes next. What are the second and third order effects of exactly what you just said? But, well, if you owned an hedge fund and you saw that and you couldn’t reconcile that in your mind and you just have this sort of nagging fear that, again, comes from our…

TOM GAYNER: Or evolutionary wiring as human beings that that somebody knows something you don’t or there’s something wrong that might cause you to sell the stock it’s a legitimate response to things well if you’re selling the stock all other things being equal the price of the stock is going down so that is creating something of a self-fulfilling prophecy that the the shares are under pressure well as with the time horizon that i’ve been fortunate to operate on that actually is creating in the dude.

TOM GAYNER: An advantage for me because being a longer term buy and hold investors we’ve been able to be given the structure that we’re fortunate enough to operate with the very dynamic of which you speak is one of the components that is not driven by my iq or intelligence it’s driven by my behavior and the ability to choose how you behave is something that you know, it certainly requires some IQ points.

TOM GAYNER: You don’t want to be stupid and you want to be stubborn, but I do have an advantage and that advantage has been extraordinarily helpful and a huge component to why we’ve done as well as we have over the years.

TOM GAYNER: Cause I think if I was trying to compete in an IQ contest against people, I would lose a lot of those battles. There’s so many people who are always smarter and faster and stronger and better at things than you are. So you have to figure out what is it that you have that enables you to have something of an enduring advantage.

STEPHEN CLAPHAM: Yeah, I mean, I guess having the permanent Capital gives you a structural advantage over professional investors who are relying on the whims of their end clients. I think it’s huge. Yes, yes.

STEPHEN CLAPHAM: Now, look, you’ve talked about your four filters and your investment philosophy. Profitable businesses with good returns in Capital, not too much leverage. Management teams with equal measures of talent and integrity.

STEPHEN CLAPHAM: The company should have ample opportunity to reinvest its profits at handsome rates of return. And the stock must be available at reasonable price. Those are very simple filters, but I suspect that it took you quite some time to work out that combination. What did you reject?

TOM GAYNER: Well, I’m trying to remember the exact time when I first wrote that, but it was a long time ago. And those might have been some of the founding principles that I laid out in my very first days of Markel.

STEPHEN CLAPHAM: Oh, really?

TOM GAYNER: It would have been that kind of timeframe. So let’s take each of those and break them down.

STEPHEN CLAPHAM: Yeah.

TOM GAYNER: So first off, that idea of a profitable business with good returns on Capital and not too much debt.

TOM GAYNER: There are certainly legitimate disciplines within the realm of investing that don’t embrace that as a principle or rule of doing so. The entire realm of venture Capital is one. And as a citizen, as a member of society, who has benefited from the progress that has happened because of…

TOM GAYNER: Venture Capital backed activities. I root for it. It’s great. I love it, but I don’t know how to do that. So again, in order to be a good investor, I think you need to know what you are good at and what you have some skills that rather than try to ape behaviors that other successful people might have, they might be very good at it, but you yourself cannot be good.

TOM GAYNER: It’s just not going to do you any good. So as somewhat of a plotter and a, and a slow, steady guy. The idea that a business is profitable is extraordinarily important to me because one of the things that that says to me is that business is voluntary.

TOM GAYNER: The purchase and sale of products or services is normally not done at the point of a gun.

TOM GAYNER: If I’m selling and you’re buying, that means I’m doing something for you or providing you with some product or service that you need or want, and I’m doing it at an efficient enough…

TOM GAYNER: So that you choose me as opposed to some competitors to provide you with that. And the profit margin means I’m good at it enough that I can do it and create profits from doing so. So it is really a stamp of approval from society and from individual people that what I am doing is of value to other people.

TOM GAYNER: So there’s just something deeply reassuring and satisfying. And enduring about the notion that you are consistently earning a profit from your activities, it means the world wants what you’re doing. And if the world wants what you’re doing, that increases your odds of survival quite a bit.

TOM GAYNER: And I joke, there’s roughly 8 billion people in the world. I’m one. So if I can get the other 7,999,999 to at least not hate me and perhaps be grateful for what I’m doing. That increases the likelihood that I get to survive it and do well. So can I just interrupt you?

STEPHEN CLAPHAM: Sorry, because I mean, I haven’t had anybody on this podcast that said they bought stocks with low returns in Capital. When it’s kind of a given for almost every equity investor.

TOM GAYNER: I would push back on that a little bit in the sense that, well, I agree with you that nobody might articulate it that way. But there are certainly people that will buy things that are not making any money. And it’s just not a function of their thinking.

TOM GAYNER: Now, I think what your suggestion is the gray area of if you want returns on Capital of 10%, 12%, 15%, there’s nobody coming in here and arguing passionately for things that make 4% or 6% or 8%. And I would agree with you about that.

STEPHEN CLAPHAM: And as a consequence, those things have been re-rated. There aren’t opportunities to find very cheap companies that have got high returns anymore.

TOM GAYNER: By and large, that’s true. I don’t think about it in that particular construct, because if you’re talking about sort of the 4%, 6%, or 8% kind of return businesses and what they sell for, I mean, there’s a realm of investors, and Ben Graham was one of sort of the original teachers and practitioners of sort of deep, what’s become known as deep value investing, where the price of the shares might be so cheap.

TOM GAYNER: That there was an opportunity for re-rating, as you call it, to move stock prices. Early in my career, I would have engaged in some of those kinds of practices. As time has gone by, I find myself doing less and less of that all the time, because usually if you see something earning subpar returns.

TOM GAYNER: There’s a reason for that. And those reasons tend to be more persistent than you would think. So the phrase value trap is one that’s used where a cheap stock is often something, it’s a business that’s not that good. And if it’s not that good, it’s probably unlikely to get that much better. But it’s just not a realm that I think so much about.

STEPHEN CLAPHAM: And you particularly emphasize reinvestment opportunity.

STEPHEN CLAPHAM: How do you sort of identify that? So you’re looking at an equity investment. How do you know how much reinvestment opportunity there is?

TOM GAYNER: Well, you know, I grew up in the Delaware Valley, so sort of in the shadow of Philadelphia. And one of the patron saints of Philadelphia, and here I am on English soil saying this, but he spent some time in English soil, was Benjamin Franklin. And Benjamin Franklin said, money makes money, and the money money makes makes more money. And he was speaking of compound interest and compound returns. So what…

TOM GAYNER: Really drives a fulsome investment return over a long period of time is not so much the return on the Capital that exists in a business at the instant that you buy it. But when that company makes money, what do they do with it?

TOM GAYNER: And what are their incremental rates of return going forward? And it is through that mechanism, the reinvestment of Capital over long periods of time that, that dramatic things, take place. That’s where compound. Returns to Jim.

STEPHEN CLAPHAM: But how do you identify what the opportunity is going to be? Because those opportunities change over time. You know, if you, you’re owning companies for decades and you know, you, you might have a visibility of the next decade, but you don’t have any visibility beyond that. So how’d you think about that?

TOM GAYNER: Well, again, I think this is where it helps to be a bit of an iconoclast and sort of follow your own sense of things. So one time I can recall, I was at a meeting and there had been an article in The New York Times the day before. And it was one of those normal things once he’s in the dining section about the best restaurants in the world. And there was, I don’t recall the name of the restaurant. I think it was in Copenhagen.

TOM GAYNER: No, no, exactly.

TOM GAYNER: So that was talked about. And I knew that the crowd that I was addressing. Would have read that article and been familiar with that place. So I cheekily asked the question. I said, so if you had to identify what you think was the best restaurant in the world, what would you think it would be? And sure enough, they took the bait and many named that and talked about that.

TOM GAYNER: And I said, well, you know, from my point of view, actually, I think the best restaurant in the world is McDonald’s. And you could see the people shudder, shudder. The fact that I said that, but it depends on what criteria you’re using to make that statement.

TOM GAYNER: So that Nomu place, and again, I’m not a gourmand or gourmet, I am way outside my area of expertise on this sort of thing. I’m guessing that might be a single location place with a single location kind of owner. And I would guess if they tried to replicate that experience to 20. 200, 2000, 20,000 times like McDonald’s has, it probably would not be rated as the best restaurant in the world.

TOM GAYNER: It is just an entirely different skillset to run something that’s extraordinary and do it one time versus doing it a hundred thousand times. So what I would admire about McDonald’s, and again, I, I see people’s body language when I, when I say these sorts of things and I see how appalled they are. And it just is a, is a different, a different mindset.

TOM GAYNER: The way in which they have systematized and been able to repeat the practices and behaviors over and over and over and over again over a period of 50, 60 years, it’s extraordinary.

TOM GAYNER: So that is an example of reinvestment dynamics at work where the Capital, when McDonald’s sort of started, when the McDonald brothers there in Southern California with one place and Ray Kroc saw how it could be systematized and done over and over again. That’s really just another way of describing and vivifying what it is to reinvest.

STEPHEN CLAPHAM: Yeah, well, it’s a good example. And my kids have never eaten in McDonald’s.

STEPHEN CLAPHAM: My wife is very into nutrition and has forbidden it.

STEPHEN CLAPHAM: And well, they have actually eaten at some Michelin star restaurants, so not normal. But, um… Talking about your portfolio, so your top 40 positions, 80% of the portfolio, 90% in the top 57.

STEPHEN CLAPHAM: Outside the top 40, you’ve got another roughly 100 positions covering 20% of the portfolio. And you call this farming. So explain to the listeners how that works. And can you talk a little bit about how you’re organized and how you can monitor that number of companies?

TOM GAYNER: Well, farming is one thing. I call it library cards is another example. And again, this would be an American-style description. Cultural point, we just finished the World Series. So if you have a baseball team, a major league baseball team in the U. S., generally speaking, there’s a series of farm teams that are part of that organization.

TOM GAYNER: So you have the AAA club, you have the AA club and the single A club and an organization, the Los Angeles Dodgers just won the World Series. They will have fresh, young, new players come in that are not. Perhaps major league quality yet, but they’ll be playing within the system at the single A, double A, or triple A level.

TOM GAYNER: And that will be dynamic and the sort of thing where if players are starting to break through and show higher levels of talent and maturity and skill development, they’ll be moved up with the ultimate goal that they make the major league team. And similarly, sometimes people sort of drop down a level to.

TOM GAYNER: So really the investing process is for me is somewhat similar to that. I find that, I study a company more closely. I pay attention to what’s going on in the news a little bit more. I just develop more of a sensation if I own at least a little bit of it. So the actual financial impact of a very small position is not too meaningful, either good or bad when it, when it goes up or down, but there are signals that’s.

TOM GAYNER: That come from awareness of having a broad array of companies that I find helpful in making sure that the major league roster, the top 20 holdings, things of that nature, do indeed reflect the standards in quality and have what I’m looking for.

STEPHEN CLAPHAM: How do you keep track of them all, though? I mean, 140 stocks.

STEPHEN CLAPHAM: We were talking before we came into the studio about, I interviewed Anthony Bolton 12 months ago.

STEPHEN CLAPHAM: And I asked him how he managed. I could never get, because he would, because he liked to own mid caps. And of course his fund got huge and he ended up with a couple of hundred positions. I couldn’t imagine how you could monitor that.

TOM GAYNER: I think the degree to which you’re monitoring is different for different people. Yeah, no, sure. If you ask me if I have detailed quarterly reports and models on all of those companies, no, the answer is no. Now. But. What I’m really looking for is the sensation and the quality of the management, the industry, what’s going on in the economy that one gets just from awareness.

TOM GAYNER: So all day, every day, what I tend to do is read, look at news flows, talk to people, whether that’s management teams, whether it’s people running businesses, whether it’s my friends, whether it’s fellow investors, just to continuously get that sensation. Of things that are either going well and hanging in there or getting better or deteriorating.

TOM GAYNER: And in the flow of that just daily work, the sensation of what you’re adding to and what you’re subtracting from and what you’re leaving alone. And again, our turnover is extraordinarily low, which also reflects the nature of the game we’re trying to play, to buy things where one can tolerate quarter to quarter vicissitudes and volatility. In order to get higher long-term returns.

TOM GAYNER: You don’t need to monitor that in the same way that one would need to, as you were speaking earlier, of if you were in a hedge fund and you experienced some price volatility that was unexpected to you, that is a challenge. That is an issue for you.

TOM GAYNER: It’s not a zero issue for me, but it is much less of one, given the nature of the Capital that we’re managing.

STEPHEN CLAPHAM: You don’t like selling because you don’t like taxes.

AD: I would agree with that.

STEPHEN CLAPHAM: So I was interested because I was reading William Green’s chapter in Richer, Wiser, Happier. And he said that CarMax was your second largest position then, which was, I don’t know, it was 2019, 2020, he published that book. And it’s now number 104, I think.

STEPHEN CLAPHAM: And you’ve got like $9 million in it, which is, I mean, not a rounding error, isn’t it? Is that a good example to use to understand what would make you sour?

TOM GAYNER: Well, I mean, it’s certainly a real example. So no examples are perfect, but let’s take that one. Frankly, the…

TOM GAYNER: Catalyst for me selling CarMax was the onset of COVID and the disruptions that happened in the market at that particular point in time.

TOM GAYNER: So one of the things I did was in effect, re-underwrite and rethink through all of the positions. And certainly it’s triage.

STEPHEN CLAPHAM: You do the major ones first and CarMax was second largest position.

TOM GAYNER: So I was even thinking about it quite extensively. I would say to some degree, I made a mistake.

TOM GAYNER: But it’s halved in price. Correct. Now, but I didn’t like my process. So I just want to be honest about that. So the driver of that sale was to some degree some concern about what would financially take place at CarMax. And so it turned out to be dead wrong. So the idea that I had in my mind that car sales would be under pressure for a while on account of Kevin, that turned out to be dead wrong.

TOM GAYNER: Car sales actually held up. Quite well and used cars as well. And the stimulus programs all caused some unexpected behaviors to take place that if I had written down my thesis as to why I was doing it, you should give me an F on that particular exam.

TOM GAYNER: But at the same time, what was going on was we were faced with very challenging insurance market conditions. And we had the toughest underwriting quarter we’ve ever had in the history of Markel. And in the early days of COVID, but you couldn’t. Say with certainty, what would happen? You needed to allow for the possibilities.

TOM GAYNER: As Peter Bernstein once wrote, the definition of risk is more things can happen than do happen. So as a risk manager, I needed to be very thoughtful about some of the things that could happen. So my number one goal was for Markel, the Markel Group, to continue to be ready and able and willing to answer the bell for the next round of the fight.

TOM GAYNER: So in essence, I took about 20% of the chips off the table that we had in our equity portfolio holdings. So there was a triage of what decisions and what stocks were sold in order to reduce the overall equity exposure, just to make sure our financial circumstances were as bulletproof and as fortress-like as they possibly could be. And Carmix was just one of the things that was…

STEPHEN CLAPHAM: Sold in that particular way. It was just a casualty. And very honest of you to admit that your thesis was wrong. But I mean, used car prices went through the roof and they probably minted money for a while. And then I am. And by the way, thank you for saying that.

TOM GAYNER: But I think that is one of my foremost duties is to be honest and tell the truth and admit when you’re wrong. I’m a flawed human being and I make mistakes all the time. And the worst possible thing you could do is pretend you didn’t and that you weren’t flawed because that would cut your feedback loop. Not to be accurate.

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TOM GAYNER: So one always just… Just as you were saying earlier, if you were in a hedge fund and you see Berkshire go down, when you see the best investor ever in the world sell something that you own, you ought to at least have a little bit of concern about your own judgment. And what does he know that I don’t know?

TOM GAYNER: But that said, Apple has just been absolutely brilliant at creating an ecosystem for which I know personally, got an Apple product sitting here in my… In my pocket right now as do most people that i know i know i have a monthly bill that i pay Apple for various and Sunday subscription services and it did it it seems like that’s likely to persist for a while the the stock is reasonably priced they keep repurchasing it they.

STEPHEN CLAPHAM: Got a lot of things going for them they’ve been on the fringes of this whole AI craze do you think that’s like a smart strategy not burning money or do you think there’s that they have actually been sidestepped and left behind?

TOM GAYNER: Well, I don’t know. But the exact phrasing that you just asked me that question is, AI craze, putting those two words together, changes the meaning from AI to AI craze. So Apple will be judged to some degree on whether it was just AI and something that fundamentally changed the world, or whether it…

TOM GAYNER: It leaked over and exploded and sort of metastasized into a craze where perhaps some big Capital was allocated in ways that didn’t earn returns. And the jury is still out on those questions. I don’t know the answer to that.

STEPHEN CLAPHAM: Well, I think it’s inevitable that Capital will get burned. I mean, in any technological revolution, that’s what happens, whether it’s the canals in the United Kingdom.

STEPHEN CLAPHAM: The early 19th century or the railroad i mean this is what happens with the technological i don’t guess i don’t disagree with that i mean obviously AI is important as a lens to look at companies now because there’s no question that it’s going to create massive changes in the world you’re in a unique position because AI is actually quite important for the insurance business right You just talk a little bit about.

STEPHEN CLAPHAM: Now you’re looking at a new investment.

STEPHEN CLAPHAM: How do you think about the effect of AI going forward? Especially, you know, if you’re going to own something for 20 years, it will have an effect on everything in 20 years. So how do you think about it?

TOM GAYNER: Absolutely. Well, AI is no different than anything that I’ve always thought about if we just broaden the topic out to technology. So in any business that I look at, I think to myself.

TOM GAYNER: Does technology improve or enable this business? Does technology destroy this business? Or does technology not have that much of an effect on this business? And everything I’ve looked at for, I can’t remember not thinking about that for 30 or 40 years in that way of every particular business that I look at. And in general, again, just getting back to the idea that I’m not a venture capitalist and those are not my skills.

TOM GAYNER: I tend to gravitate towards the sides of things where AI does not have, or technology does not have that much effect on a business itself. So for instance, again, citing Berkshire and you look at some of the businesses they have, one of which is the railroad business. And in addition to the railroads that we would own through our Berkshire position, we own Union Pacific, we own CSX, We are Norfolk Southern, railroads.

TOM GAYNER: Which are worth studying for many, many reasons and all of the historical reasons as well, I think that AI is unlikely to fundamentally disrupt or displace the idea of railroads. Those trucks have been built. The trucks next door to them are not going to be built.

STEPHEN CLAPHAM: I would disagree with you, though. I would say that there is a… Because one of the railroad’s principal competitors, the principal competitor is their truck. And I listened to the chief executive of Aurora Innovation, whose name escapes me, but I listened to him speak a couple of weeks ago, Italian Tech Week, and…

STEPHEN CLAPHAM: He, I mean, a very serious guy. He’s been in automotive, automated vehicles for 20 years, 12 years in. He set up this business and he was saying that, you know, 2028, they’ll have self-driving trucks on the road. Well, you earn quite a lot of money as a truck driver. So the economics are going to change.

TOM GAYNER: That is correct. And that’s probably inevitable, whether it’s 2028 or 2038. It is certainly trending that way. But fuel is also an issue. So railroads do have quite an advantage in terms of fuel costs.

STEPHEN CLAPHAM: You might have electric trucks.

TOM GAYNER: I don’t disagree with your notion. But I think one of the things to acknowledge is that we oftentimes speak of these things in binary ways. Zero or 100. This is going to change. This is not going to change. As a friend of mine says, people have forgotten. There are numbers between zero and 100. So it might change 10%. It might change 80%.

TOM GAYNER: But on the scale of things that are changing or not changing, it would be my point of view that because of the fundamental laws of weight and gravity and mass and fuel and embedded networks, railroads do have a role to play. And one of the things that can also happen within the operation of that business through AI and…

TOM GAYNER: Using technological tools, they can probably lower their cost of operations to some degree as well in the face of competition from truckers. And by the way, railroads have been losing market share to trucks for a while now. So that is not a new thing.

TOM GAYNER: And that is a competitive dynamic that moves back and forth over time. And railroad managements are not unaware of the things that they can and should be doing to try to be competitive. But I just offer that as an example of something that on the scale of things, I would think would be less affected than many other things.

STEPHEN CLAPHAM: No, I’m sure. I mean, obviously, most stuff will still go by rail, right? But it might change a lot. What about within Markel? Can you give us some examples of, you know, how the business is using AI? I mean, you know, I was just thinking about, I was just trying to think about an insurance company. And maybe if you’re offering life assurance, there are new diagnostic.

STEPHEN CLAPHAM: Tools to keep people in better health, but also give you a better calibration of risk. I mean, this is a business with a long-term horizon. These sorts of tools presumably will be hugely valuable and enable you to be much more efficient, much more effective. Can you just talk a little bit about how you see that?

TOM GAYNER: I mean, that’s exactly right. Now, we’re not in the life insurance business, so that particular example would not be relevant to us. But the… Two sort of factors of what AI can do for us in terms of a tool. One example would be the gathering of information in order to price a risk.

TOM GAYNER: So one of the things that we would tend to offer would be forms of property insurance for chains of business. So somebody who owns 20 stores or 30 stores or different locations. In order to collect the information that would be required. Even to just produce a quote has historically been pretty labor-intensive and manual and a lot of papers and data to be gathered.

TOM GAYNER: The tools of AI have increased the speed at which we could do that already by a meaningful amount. So that speaks exactly to what you’re talking about. I was having dinner with a fellow last night, and we were talking about one particular product line and the degree to which attorneys needed to scour documents and look.

TOM GAYNER: Look for this or look for those patterns. And we are using AI tools to do much of that work. And again, it increases the speed and probably the accuracy to some degree of what those risk factors are. So it’s a tool of doing business.

TOM GAYNER: And we, like every other company that competes even remotely with us, we will all be using it. The idea that one of us will have a competitive advantage over the other on account of that is probably… Only short term in nature because it’s the sort of tool and technique and practice that everybody in the industry will adopt.

STEPHEN CLAPHAM: Yeah. So you might get, you might get an edge for a short time, but then somebody else will catch you up. And yeah.

STEPHEN CLAPHAM: You obviously take a great deal of care in crafting your annual letter, which is really good. Well, how long does it take you?

STEPHEN CLAPHAM: What’s the process? And it’s clearly very important to you because you’re speaking not just to shareholders, but you’re also speaking to employees. Was my sense from reading it. Can you just talk a little bit about that? And can you also talk a little bit, I mean, there’s a few good examples in the United States. There’s very few good examples in Europe. So the next annual letter is brilliant. It’s fantastic.

STEPHEN CLAPHAM: I struggle to name half a dozen where I could list loads of them in the U. S.

STEPHEN CLAPHAM: Why do you think more people don’t pay attention to this? And is it really difficult to do?

TOM GAYNER: Well, sometimes people ask me how long it takes to write that letter. And I say, well, there’s two answers to that. One is two weeks and the other is a lifetime.

TOM GAYNER: So. I do sort of devote two weeks of time in around the Christmas holiday, New Year to sort of be by myself and write the bones of that letter.

STEPHEN CLAPHAM: And it does consume a good amount of that particular time from the other answer. I think actually about why letters like that are rare is complicated.

TOM GAYNER: But here’s one element to that. I think the structure…

TOM GAYNER: Of the market and the structure of ownership of public companies right now has changed rather dramatically over the course of the last 20 or 30 years. And I suspect it will continue to change and evolve, and there might be some circularity, there might be some sort of reemergence of some ancient practices as time goes by. But here’s how I think it might play out. So when Markel went public in 1986.

TOM GAYNER: There were roughly 7,000 public companies in the U. S.

TOM GAYNER: I think that number is down to now a little over 3,000. So the amount of public companies per se has diminished. And there’s all kinds of reasons why that is the case. I would say part of that, just part of it, is the growth of indexing and passive investing.

TOM GAYNER: So as a little thought experiment, I would offer you this. This mental exercise and your listeners as well. Think of a thousand people that you know, and I’m not asking you to talk about a thousand investment professionals, but neighbors, friends, teachers, community members, fellow parents, lawyers, doctors, on and on.

TOM GAYNER: Just picture a thousand random people. And of those thousand random people right now, how many of them by this time who are… Professional, thoughtful, well-educated, connected people, how many of them have heard of Berkshire Hathaway or Warren Buffett?

TOM GAYNER: Care to hazard a guess?

STEPHEN CLAPHAM: Oh, I would say, I mean, over 90%.

TOM GAYNER: Okay, I agree with you. Now, of those 900 and some that at least have some intellectual familiarity with Berkshire or Buffett, how many of them actually own a single share of Berkshire? A or B spheres.

STEPHEN CLAPHAM: Well, if you’re talking to investment professionals, it might be a different answer, but it would be 1%.

TOM GAYNER: Agreed. So out of the 900 people that knew about it, only nine own it, maybe 90, but the point remains the same.

TOM GAYNER: Well, I think that’s fascinating. So why is it that all of us know about this, but yet so few of us have acted upon it? Well, I think one of the reasons why that’s the case, and again, this is not the exclusive 100% answer, but one of the reasons is the industry practices have gotten to be such that people are terrified and they’re counseled to be terrified of owning an individual security.

TOM GAYNER: Their financial advisors would talk about idiosyncratic risk and the risk of something bad happening to any one company. So as a practical matter.

TOM GAYNER: And it’s been for good reasons to start.

TOM GAYNER: The idea of owning indices has become the standard practice that people would have in their own personal financial life. And that has spilled out to whether you’re an investment professional or not.

TOM GAYNER: Even if you don’t own an index, the outstanding performance of indices has caused a lot of professional managers to some degree ape and not to get too far away from how well the index. In and of itself is doing, which brings up a whole lot of other things. But that behavior has happened.

TOM GAYNER: And as a consequence, I think that the ability of people to think independently about individual companies has diminished to the point where I think there is increasingly pricing errors being made where there are not enough active people sort of doing the work of thinking about.

TOM GAYNER: What a stock should sell for as part of the business, just because the structure of the business, the structure of the industry has pushed us away from thinking about individual ownership of common stocks. Now, to some degree. Part of the growth of the private equity industry has been to arbitrage away those discrepancies.

TOM GAYNER: We have very smart people within that industry who are doing the work and are figuring out what something should or shouldn’t be worth. And when the gaps get too large, they tend to come in and try to arbor away that gap by buying the public company and putting it into private markets.

TOM GAYNER: So why was indexing started? Well, John Bogle had a great idea. That if you reduce the costs, the net returns for the investor would be better. But as is often the case within Wall Street or the investment world, you take a good idea and you do it so much that it becomes a bad idea.

TOM GAYNER: I’m not saying where we are along that spectrum, but I’m saying that it seems to me we’re doing a bit of that. And in the fullness of time, in the fullness of financial history, what tends to happen is that if there’s something that’s probably.

TOM GAYNER: Not right or wrong. It gets resolved over time through some way or another. So I would suspect if you live long enough, we will again see the return to actual public companies in existence and people being thoughtful about owning individual public companies and what they own and what they don’t own.

TOM GAYNER: But it’s just one of the streams and one of the things that’s going on out there that gives thoughtful people the opportunity to think and work at it and be thoughtful and use the brainpower they have to make good decisions.

STEPHEN CLAPHAM: Of course, the problem with that is you can buy these cheap stocks, but they can stay cheap for a long time.

TOM GAYNER: They can, but if they are intrinsically creating internal cash flows and operating as profitable businesses, even if they’re cheap, generally speaking, managements who are awake should either be Buying other companies like that, which would increase the value of their company, or repurchasing shares, or doing some things which would be acknowledging the fact that the securities might be mispriced.

TOM GAYNER: So there are things managements can do in the wake of that.

STEPHEN CLAPHAM: I mean, David Einhorn was saying that, you know, in the old days, he used to buy stocks before Fidelity and Capital. And when those active managers spotted the situation, they would come in and he would get out. He said, no, they’re not. Coming in to the same extent. So he’s reliant on owning companies where the management will buy back the stock.

TOM GAYNER: Correct. And I think I did read the reports that he said about that. And I think he went so far as to say he didn’t think it would ever change.

TOM GAYNER: Now, he may or may not be right about that, but he was, I think, willing to make investments in things, even if he didn’t think it was going to change because the intrinsic value creation in and of itself, I mean, if you have something and it’s only selling just to pick a silly number. For six times earnings or something like that.

TOM GAYNER: Well, even if it only sold for six times earnings 10 years from now, but the earnings tripled in that timeframe, the value of your security should triple as well. And by the way, in the course of 10 years time, I suspect we will see different environments where things get valued differently than what they are now, both up and down, which would create some additional headwinds or tailwinds for any given security.

STEPHEN CLAPHAM: And just going back. Back to the letter. Do you think more people will follow your lead and Buffett’s lead in writing that sort of very personal letter? Because it’s very obvious to me when I pick up an annual report, a 10K, and I read that. I mean, you know, instantly, okay, I can tell you’ve written that letter. You haven’t delegated that to someone else. Same with Mr. Buffett. Do you think it’ll become more fashionable?

TOM GAYNER: I think so over time. And again, it ties back to if the only person who owned Markel owned it because it was part of an index, probably not.

STEPHEN CLAPHAM: No, sure.

TOM GAYNER: It wouldn’t be of value. But if an increasing percentage of our shareholders own it because they want to own Markel and they seek to know something about Markel, well, that letter will become more and more important to them. Now, one of the things that is the case at Markel is we have a lot of employees who own chairs and through our.

TOM GAYNER: 401k plans and things of that nature our employees are our shareholders as well and i can assure you as i talk to the people who are the people of Markel and the employees and associates of Markel they care which is great and i’m happy about that so even if it was just to them that would be a value and frankly even if that letter was just to me writing it again in that spirit of honest self-appraisal.

TOM GAYNER: And honest admission of mistakes and honest post-op reviews of what worked and what didn’t view. Even if I was the only person who read that letter, it would be worth doing.

STEPHEN CLAPHAM: It’s interesting. Fascinating. In the letter, you value your business, is it 12 times three-year average earnings?

TOM GAYNER: That was a rubric that we put out there just to give people some sort of mechanical way to try to have some consistent methodology. Not so much for making a spot on precise estimate of what the shares were worth right now. But whatever number you take, whatever mechanism you use, if you do it consistently year after year after year after year, what you get is a directionally correct rate of change.

TOM GAYNER: And that’s what we were trying to communicate because we… We hear the commentary from people that, you know, I can’t understand Markel. I don’t know what you’re doing and how I should value it. And I say, okay, let me accept that. Here is some reasonable methodology that you might think about using as proxies to determine what’s happening economically.

TOM GAYNER: And again, the degree of difference one could possibly have about your single point estimate could be wide. But the most important thing is if you agree on the methodology, and even if you pick a different one, do whatever one you want consistently over a number, a multiple number of years, and then I think the quality of the data you get from doing that goes up a lot.

STEPHEN CLAPHAM: No, no, sure. I was just curious as to why you picked such a low number.

TOM GAYNER: It was meant to be something reasonable. I don’t want anything that people would say, oh, that’s a ridiculously high, you’re inflating the value. So I didn’t want to do that. So just pick something that seems reasonable. And even within that, we, we offered a range.

TOM GAYNER: We didn’t have a single point number. He said, you know, we, you can use this number at eight. You can use it at 12. You can use it at 60. You can use anyone in between anywhere. You can use whatever number you want. I don’t care. What matters is that you pick something and you be consistent with it.

STEPHEN CLAPHAM: Yeah. So I worked for the largest financials hedge fund in the world and I did the non-financial stuff.

STEPHEN CLAPHAM: And When we went out to lunch, you know, the analysts would go out to lunch and the insurance guy would be talking to the bank assurance guy and they were like speaking a different language, you know, the rest of us would be looking at each other, you know, and I decided long ago it was far too hard for me, but I’m in the middle of my annual sort of boot camp.

STEPHEN CLAPHAM: So, you know, I teach people how to be better at reading 10Ks and we do a Zoom-based boot camp.

STEPHEN CLAPHAM: And this time… One of the participants is a former partner of one of the big four audit firms. And he was an insurance expert. And he’s doing my boot camp because he wants to get non-executive roles. He’s retired.

STEPHEN CLAPHAM: And so he wants to learn about companies beyond insurance. And oddly, it was coincidentally, one of the guys asked last week about insurance. And I said, well, insurance, I don’t know anything.

STEPHEN CLAPHAM: Don’t ask me. And he said, oh, actually, Steve, you’re underestimating yourself. Asset side of the Balance Sheet is quite easy. You just need to worry about liabilities. So I thought that was quite clever, right? So all you need to worry about is are you adequately reserved?

STEPHEN CLAPHAM: And I thought, oh, that’s quite interesting because I know that Berkshire will be adequately reserved. I know you will be adequately reserved. But how would I look at a different type of insurer? So Kinsale Capitals and equally, is it also in Richmond?

STEPHEN CLAPHAM: Specializes in the excess and surplus lines insurance market, which sounds pretty risky. How would you go about assessing whether that company was adequately reserved or not? Or any company?

TOM GAYNER: Yeah, I’ll tell you exactly what I do. And again, this is not a point estimate. And it’s not something that I would ever attach 100% certainty to. But I think a pattern can emerge. As an old accountant, whenever somebody asked me a question like that, I would say, okay, let’s pick whatever company it is you want to talk about. Let’s look at the annual report and let’s turn to the Balance Sheet.

TOM GAYNER: And what number on that Balance Sheet is the single biggest number? So on insurance companies, typically the answer to that question is the loss reserves. The estimate that the company has put up for what their ultimate liabilities are, as you speak of, that’s what they think the insurance claims will ultimately be is that loss reserve number.

TOM GAYNER: That’s the biggest single number. Well, then I looked back at them and after they passed that exam of just being able to take their finger and point at the biggest number, I said, as a former, as a former certified public accountant, I will certify to you only one thing.

TOM GAYNER: That number is wrong. That number is wrong. It would be a sheer miracle if that happened to be the right number. Now, the interesting question is, is that wrong the right way or is it wrong the wrong way? And wrong the right way means that the company has more than adequately reserved.

TOM GAYNER: So what you’ll see is there are patterns, and these are reported in the 10-Ks and things of that nature, where you have lost development triangles. Which update year by year. So if a company put up a number 10 years ago and it was a billion dollars, what you’ll be able to see in the financial statements of the last 10 years is through each and every year, how did that number change over time?

TOM GAYNER: And if that billion dollars that was provided for 10 years ago now is at 927 million or something like that, that is an extraordinarily good indicator that The company was conservative, and that number was wrong the right way.

TOM GAYNER: And if you look at companies for a long enough period of time, and you see that pattern persistently repeat itself over and over and over and over again, where those reserves developed favorably, what that tells you is a little bit of a financial measurement, but it tells you a huge character measurement. So the management of that company was not in a… Hurry to recognize earnings.

TOM GAYNER: And I think this ties to your work extraordinarily well, because what you’re trying to discern in so many cases is the quality of that management and integrity is a huge part of quality. So if that management team has demonstrated the fact to you through consistent performance that they have been conservative, they are indeed demonstrating a pretty strong marker of high quality and integrity to you.

TOM GAYNER: So what we try to do and what we look for and what I would look for as an analyst in looking at insurance companies is how that number develops over time. And the way it develops over one or two years is good, but that’s not enough. You need to see five and 10 years worth of data before I think you can start to draw valid conclusions.

STEPHEN CLAPHAM: It’s interesting. I mean, one observation I’ve made is that the amount of earnings management going on generally, I mean, notes. Talking specifically about insurance companies, but just generally in the stock market. And, you know, it goes from, you know, small companies right up to the largest companies in the world.

STEPHEN CLAPHAM: I wrote last week in my newsletter, in my sub stack, about server lives. And, you know, they’re all using different server lives. And Amazon has shortened its server life. It would seem quite likely that others should be following suit, but they’re not.

STEPHEN CLAPHAM: And this makes a huge difference to reported earnings. And it seems to me that earnings management, I mean, I’ve been doing this for a long time. I don’t remember it’s ever been as prevalent. I mean, do you have any concerns about that outside the insurance world, in the broader industrial consumer world?

TOM GAYNER: Well, I’ve been giving you long answers. Let me give you a short one.

STEPHEN CLAPHAM: Yes.

SPEAKER 4: Okay, good.

TOM GAYNER: And so, but now let’s do the longer answer as well. So in an insurance company, quarterly report. And this would also be true in a bank company quarterly report. Every quarterly report is something of a wrestling match, a tussle between the income statement and the Balance Sheet. So earnings would be income statement oriented information.

TOM GAYNER: And you can always, almost always, as an insurance company or bank, kind of make this quarter’s earnings okay. Perhaps at the cost of weakening your Balance Sheet a little bit. Markel is a Balance Sheet-oriented company. The Balance Sheet comes first.

TOM GAYNER: And again, that ties to that statement earlier that I made about the reserves being more likely to be redundant than deficient and having years and years of data that would indicate that the Balance Sheet is first and foremost. So to the extent that you have income statement sort of favoring the shorter-term earnings, that That comes at the expense of Balance Sheet strength.

TOM GAYNER: And as investors, what do people focus on more? Do they focus on income statements or do they focus on balance sheets? When I’m an analyst and I’m looking at any particular company, I tend to look at the Balance Sheet and the statement of cash flows first and the income statement after I’ve looked at those first two.

TOM GAYNER: You need to look at all three and you need to look at them comprehensively. But which one do you look at first? Which one do you look at second? Which one do you look at third? I think gives you an indication as to what your time horizons are and what’s most important to you.

STEPHEN CLAPHAM: It’s funny because I look at the Balance Sheet first as well and the cash flow. But, you know, in the United States, your discretion is to which you show first. So I always think it’s quite interesting to look at, you know, when I look at a new company and look at the 10K, which is the first financial statement? And nobody’s ever said to me, oh, look at that. They’ve got the cash flow first.

TOM GAYNER: You’re the first person who has said that to me. So that’s an interesting observation.

STEPHEN CLAPHAM: You know, it tells you something about, I think the psychology of the CFO is very important.

STEPHEN CLAPHAM: We’re closing in on time. I’m going to ask you about, to recommend a book, but just before we do that quickly, I’m very interested because you’ve sat on a lot of boards and you’ve sat on some amazing boards with some amazing people. And on your own board, you’ve got Lawrence Cunningham.

TOM GAYNER: Yes.

STEPHEN CLAPHAM: And Morgan Housel.

TOM GAYNER: Correct.

STEPHEN CLAPHAM: So two people that are not normal kind of non-executive directors, just. Give me a quick snapshot of what’s surprising about boards and what’s been surprising. What have they contributed that surprised you and what surprised you when you’ve sat on other boards?

TOM GAYNER: Boards, for me, have been a spectacular learning experience. So it is the opportunity to be with truly world-class people that are operating in different realms, different businesses, and to share time and meals and experiences with people who are in different circles. You can’t, I mean. If your mind and your eyes and your ears are open at all, you can’t help but learn things.

TOM GAYNER: So it’s been an extraordinary ability to just be exposed and to learn. So it’s of great value. Speaking specifically about our own board, and I’ll tell one story about Morgan Housel. So I was aware of Morgan when he was working at The Motley Fool. And I saw his writings and I just thought, boy, this is really good.

TOM GAYNER: And on his blog, he wrote a piece which I recommend reading called The Three Sides of Risk.

TOM GAYNER: It’s a seminal piece and one that if you read that, I don’t think you can help but be changed by reading it. So after I read that, I became more interested in Morgan and followed more of his stuff. And, you know, we meet a director or two from time to time.

TOM GAYNER: So the thought popped up in my mind that Morgan might be a really good director. So I called him and we started chatting on the, on the phone a little bit and getting to know one another. And then I, I suggested that I come out to Seattle and visit him and spend a day together. And we, we walked around Seattle and just sort of chatted about things.

TOM GAYNER: And finally at the, at the end of the walk, we’re sitting down, sharing a bowl of soup or something. And he said, Tom, what, what, why do you want me to be a director? And I looked at him and I said, Morgan, You were the oldest 38-year-old I’ve ever met in my life.

TOM GAYNER: The degree of wisdom that he has relative to the years he’s been on the planet are extraordinary. So his ability just to understand things and understand what’s good about things and understand what’s troubling about things, he’s a great friend and just has a perspective and a point of view that’s quite helpful.

TOM GAYNER: And similarly, Larry was one of the first folks to really. Figure out Buffett. And not only did he figure him out, he documented it. He wrote about it. He, he left a paper trail before what was, what was going on there. And so it’s, it’s kind of like Chris Columbus in America.

TOM GAYNER: He didn’t, he didn’t create America, just bumped into it, but he left some records and organized some expeditions and things. So, Larry deserves a great deal of credit for being one of the early ones to document. What was happening with Berkshire and his extraordinarily helpful book.

STEPHEN CLAPHAM: Absolutely. He was a guest on the podcast, I think, last year. You’re a voracious reader. Always ask people to recommend a book to a young person entering the industry or just a book that you’ve recently read and enjoyed.

TOM GAYNER: Well, I’ll give you two, and this is especially helpful to you. One question about a young person entering the industry, this is a book I’ve given my children. The Morgan Housel’s Psychology of Money would be a book that I would… It’s a great book. I mean, I don’t know, 10 years old, anybody over 10, I think, could handle that book and do pretty well with it.

TOM GAYNER: Another book that I read and listened to recently is a book called The Cost of These Dreams by Wright Thompson. And Wright Thompson is a long-form sports writer. He tends to operate in the world of sports. And he…

TOM GAYNER: This particular book is a series of heroes, a series of things that you would know about, and writes perhaps about the pluses and minuses of them. And it’s a wonderful book to read. It’s an even better book to listen to because Ray Thompson is from Mississippi, and his own accent and punctuation and enunciation and points of emphasis add texture to the story.

TOM GAYNER: So I think you’ll— People will enjoy that, and I think it does a wonderful job of highlighting both the pluses and minuses of so many situations and circumstances. And normally, everything has both a plus and a minus. So to be. Thoughtful about what’s good about things and what’s bad about things that are the same thing.

TOM GAYNER: That’s a worthy perspective to incorporate in your thinking.

STEPHEN CLAPHAM: Tom, listen, that’s a great spot to finish. Thank you so much for doing this. It’s been great to meet up with you in London. And I really appreciate your time. Thank you.

TOM GAYNER: Delightful to be with you.

SPEAKER 4: If you bumped into Tom in the street or if you met him in a social gathering.

STEPHEN CLAPHAM: You’d never know that he was the brains behind… One of the most successful companies in US insurance, and indeed one of the most successful long-term US growth stories outside tech. I recommend his letters and having a look at his portfolio, at least the 40 major positions, as he has been an incredibly successful judge of enduring companders. Thanks, as ever, for listening.

SPEAKER 4: Behind the Balance Sheet and affiliates and podcast guests, may own shares or have an economic interest in securities discussed in this podcast. Which is aired for your education and entertainment only. Nothing in this podcast should be construed as investment advice or relied upon for investment decisions. Always do your own research.

STEPHEN CLAPHAM: Thank you for listening. I hope you enjoyed this episode. It would mean a great deal to me if you could please share this with just one friend. And feel free to spread the word by subscribing or even leaving a review on Apple Podcasts or Spotify. Thank you for your support.